I’ve been having a bit of a play with the central calculation of the Fair Tax Mark which determines whether a company pays a fair rate of tax. I call it the Fair Tax Mark Random Number Generator (FTMRNG).

Despite Richard Murphy’s protests that it may only cost a company one FTM mark at most, it can quite easily turn a five into a zero, or a zero into a five.

Any small profits are disproportionately affected by tax adjustments. And any rate in recent years disproportionately affects the weighted rate.

So here we have a company whose tax adjustments even out over six years. In this period they actually pay £5m more than the tax that you would expect them to.

Whilst this is a contrived example, it is not massively contrived and the method should be able to deal with such hypothetical situations.

In fact, that’s how you can test these sort of methods. It’s called ‘destruction testing’.

In comparison to the “expectation” which the FTMRNG infers, the company pays more tax than expected. I would expect it to get a score of five.

And yet the FTMRNG gives the company a score of zero because their weighted difference is 9% less than expected.

Mark, thanks for the comments. I don’t have much idea what a conventional press release style would be, so your thoughts on this next post, which simplifies this one, would be appreciated: http://wp.me/p2ikam-ov

It’s ironic that this Fair Tax Mark is asymmetrical, and thus gives rise to odd results, when a large part of the tax avoidance it’s supposed to highlight comes from the way that deliberately introducing asymmetries into a tax system allows for liabilities to be reduced 🙂

Thinking through the rationale for the weighting, it occurs to me that it is simply expressing an implicit assumption of the Fair Tax system: that companies may have been avoiding tax in the past but ought to be getting better. The weighting is designed to reward companies which “improve”, and to punish those which get worse.

Unfortuntately, it takes no account of the causes of the variation in ETR, which could be things like deferred tax, pension contributions, or natural fluctuations in the figures just as easily as the deliberate recanting of immoral ways.

All it does is exaggerate the impact of variations without regard to the underlying meaning. I would have thought it much better to look at variation from the headline rate over six years without the weighting, then have a look for causes of it, and then perhaps amend the mark depending on what that tells you.

Of course that brings in some subjectivity, and the Fair Tax Mark is trying to be purely objective. But that’s just applying the strict letter of the law without regard for the spirit of it – another irony 🙂